This blog has been created to pen down my thoughts on value-based investment opportunities (or the lack of them) in Indian listed companies. As an enthusiastic reader and life-long student of Behavioural Finance, i also plan to blog on various aspects of investment psychology.

Thursday, December 5, 2013

Something which is too obvious and which everyone knows about rarely works in investing. "The crowd is never right" is the gyaan we often hear and experience too.
So when the Powergrid FPO special situation presented itself, the first thing that came to my mind was that this is too obvious, which should be visible to absolutely anybody. So will it work?!

Background

Powergrid has come out with its FPO, priced in a band of Rs.85-90 per share. Retail applicants will get a discount of 5% on the final decided issue price. I am assuming the issue price to be Rs.90 and all calculations are based on the same.

So basically, retail shareholders will be allotted shares @ RS.85.5 per share. As of 5 pm on 12/5/2013, retail applications stood at 4.32 cr shares, against 27.44 cr shares reserved for the category.

The issue is therefore subscribed 0.16 times in the retail category as of now, with tomorrow being the last day for applications.

Even though most retail applications come in on the last day, I feel there is high probability that there will not be any massive over-subscription in the retail category and chances of full allotment are high.

I offer absolutely no view on the company as a business etc. This is merely a play on the situation and not an 'investment' per say.

The situation

Apply for 2200 shares at cutoff price (for retail, it will be max Rs.85.5). Expectation here is that allotment will be full/near full.

Short 1 lot (2000 shares) December 2013 series Powergrid futures @ Rs.92.85. Effectively, you are creating a near 100% hedge and locking in Rs.7.35 profit (by buying at Rs.85.5 and selling at Rs.92.85)

With the issue closing on December 6th, allotment should happen just before December F&O expiry (26th)

On expiry, sell equity shares and cover futures short position (both should be at same/near-same price on expiry, hence we would realise Rs.7.35 profit per share)

The returns here are roughly 8.3% (thats Rs.7.35 on Rs.85.5 invested per share) pre-costs for a 20 day holding period. Not bad!!

Additional points

Ideally, I would have liked to short the January 2014 series futures, but I learnt that January 2014 onwards, the lot size has been changed to 4000 shares, from the present 2000. :-( Hence, one will have to short December series itself, even though it will be a touch and go situation, time-wise.

It seems like the whole world has gotten into this trade, of applying for the FPO/going short on December series futures. Hence, the futures are quoting at a Rs.3.3 discount to the cash market price of Rs.96.15.

The whole trade is of course applicable for only the retail category, making an application under Rs.2 lakhs.

Risks

One big risk here is if the allotment is not full/near full. In that case, the cash-futures position sizes wont match and this would not be an arbitrage trade. Also, if there is part allotment along with a significant rise in the stock price before expiry (worst case scenario), there would be a loss on this trade. (Since futures price would also rise along with cash market price and hence, loss in futures market would be greater than profit in cash market)

Another risk here is if the allotment is delayed beyond December 26th for some reason. In that case, the futures position would expire and we would be left holding only the shares of company, un-hedged.

All in all, its an interesting arb opportunity that makes sense. Point is, it makes sense to everyone, so will everyone earn money in it? Lets see how it plays out.

Cheers and happy investing!!

Disclaimer(s)!!1) All the posts on this blog, including this one, are for educational and discussion purposes only.2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.3) As a professional investor, I may have positions in stocks discussed.

4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. I am not offering any investment advice through these articles. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours!